Retail banking in France, Germany, and the United States posted robust productivity growth in the late 1990s as the industry in general benefited from innovation, increased demand, and consolidation. Although the European countries inched closer to US productivity levels for the sector, a large gap remained, particularly in Germany (Exhibit 1).

The diffusion of innovations, strongly linked to IT investment, accounted for half of the productivity growth in the retail-banking sector in France during the late 1990s and for a third of the growth in Germany (Exhibit 2). In both countries, retail banking accounted for more than 10 percent of total national IT spending at this time. Half of the money was spent on back-office automation, which benefited from better and cheaper technologies such as check scanning and image processing and from the optimization of business processes such as payments. New channels—ATMs, call centers, and Internet banking—added to the productivity gains.

Electronic payments too raise productivity, and in Germany they are prevalent. Although paper checks require more labor to process, they are still dominant in the United States and, to a lesser degree, in France. Regulation needlessly prolongs their survival: US retail banks can delay the processing of paper checks and thus collect additional interest on outstanding funds, for instance, but must process electronic payments within one business day. French banks must offer free paper checks to customers, who have little reason to switch.

During the late 1990s, demand for banking services—prompted by greater personal wealth, the bull market, low interest rates, and an increasing need for private retirement plans—surged in France and Germany. The economies of scale this boom created accounted for more than two percentage points of the sector’s productivity growth there during this period. Despite the increase in demand, French and German customers are still well behind their US counterparts, who typically hold financial assets and loans worth two to three times as much as they do and undertake more transactions.

In the 1990s, faced with declining margins, banks in France and Germany turned to consolidation to cut their costs and increase their efficiency, thereby noticeably raising the sector’s productivity. But banks are still too numerous: in Germany, about 63 percent of them had fewer than 800 employees in 2000; in France, 22 percent. Without further consolidation, the benefits of IT will be greatly reduced.

French and German banks have recently enjoyed slightly higher productivity growth than their US counterparts, but work is still needed to close the remaining gap. Focusing on just one of the growth drivers—innovation, demand, or consolidation—would help but wouldn’t maximize the potential productivity gains: a bank could introduce innovations, for example, but without either swollen demand or the increased scale brought on by further consolidation, their impact would be limited. All three drivers of productivity must be exploited to achieve the full benefit of each.

Besides continuing to adopt business and technological innovations, banks in France and Germany can create demand—for example, by crafting new products and services that cater to an aging population. In France, demand could also be stimulated by the establishment of a national credit bureau and the standardization of credit reporting, which could make loans more available to a wider group of consumers. Common electronic-payment standards and more effective marketing could move customers away from paper checks.

Moreover, consolidation must continue, especially in Germany, where small and midsize banks could reap large productivity gains. Some banking functions, such as the processing of payments, could also be consolidated, either among banks or as stand-alone operations; in France and Germany, centralized "credit factories" that offer loan-processing services as a core capability have already appeared. The pace of consolidation will depend on the pressure banks face, particularly if privatization brings new owners who demand greater efficiency.